Paper Chasin

Recruit a Director that Might Fire You (And Other Start-Up Board Building Advice)

May 23/16

The following blog post is from Greg Phipps, our managing director of investment here at Innovacorp.

After working with more than 20 start-ups as an investor, mentor and board director, I have a good understanding of what works and, perhaps more important, what doesn’t work, in recruitment, care and feeding of a start-up board.

I thought I’d share my observations and advice in the hope that new founders benefit from my grey-haired perspective. This is a primer. This is Start-Up Board Building 101.

Why form a board at all?

Many of the start-ups I’ve worked with are reluctant to form a board or they place it low on their priority list.

So, why bother?

For starters, in most jurisdictions, articles of incorporation require creation of a board.

“That’s okay, my partner and I can serve as the board,” you say. But whether you’re talking about a business or life partner – either approach negates a board’s purpose and benefits. And you’re missing the point.

A board plays an essential role, having input in and oversight of strategic direction for the company and material activities that affect shareholder value. Furthermore, directors maintain a legally enshrined, fiduciary duty to act in the best interest of all shareholders and ensure management remains aligned with that priority. This fact is frequently misunderstood. I have observed many directors that believe a board seat permits them to act in the best interests of themselves or the party that nominated them to the seat – such as an investor or the CEO.

An effective board does more than police the CEO and evaluate his or her performance. Board members are coaches and champions. Board members can be trusted advisors and confidantes. Board members support a founder when he or she is hobbled by self-doubt and the omnipresent stressors of scaling a start-up.

In addition, board members can step in to serve interim roles in management when a team member is felled by sudden illness or departs unexpectedly. Boards have networks that can be leveraged to recruit employees and open the doors to potential customers and investors.

Responsible to all shareholders, boards can also call you out on inappropriate behavior, leadership shortcomings, subpar company performance, and poor individual performance. They can terminate your employment if your leadership fails to fulfill the board’s needs or expectations in the context of what is best for the company and its shareholders.

So, yes, the board can fire you as a founder CEO. You need to accept that.

I often counsel founders that they have to make a mental and emotional transition from that of a salaried employee, to thinking like a (usually significant) shareholder. As a founder or manager, you have to put your ego aside, align your thinking with shareholders and ensure the company is led by the person who can best create value and maximize return for shareholders.

Size and structure.

For a seed-stage company that is pre-revenue or just entering the market, a three-member board usually works well. That board is often best structured with a seat for the CEO, a significant investor (e.g., venture capitalist) and an independent director.

I could commit an entire post to describing “the ideal director.” For now, I’ll just suggest that the qualities you should seek include commitment, availability to work hand-in-hand frequently (this speaks to the importance of geographic proximity), governance experience with start-ups (as opposed to only with large corporations or public companies), and knowledge of your vertical. Naturally, an ideal director is also somebody with whom you have a good rapport, mutual respect and trust.

After initial commercialization and as a company starts to scale, I recommend the board increases to five members, ideally including two additional independent directors to provide for a solid and well-weighted board that is majority controlled by independents.

What not to do.

Here are a few mistakes start-ups make, to the detriment of their board’s governance and effectiveness:

They recruit friends and long-time professional or personal acquaintances. I call them “Buddy Boards.” Founder CEOs often recruit people they have known for years and who they are quite certain will remain loyal to them, rubber stamp their decisions, and never, ever, consider firing them. I once was on a board and uncovered the fact that the CEO personally recruited one of the other board members and concurrently served on the board of that member’s company. Then I found out that they both lobbied their boards for huge salary increases to the benefit of each other. “You scratch my back and I’ll scratch yours.”

They don’t engage in a formal performance review of the CEO. Seriously. Most start-up boards don’t do it. A CEO performance review should be conducted at least annually. An in-camera session should also be included on every board meeting agenda, to provide the board with an opportunity for a non-structured discussion, in the CEO’s absence, about the CEO’s performance and any issues arising from the board meeting.

They don’t evaluate their own board performance. The board should engage in self-evaluation annually, and replace members who are not engaged, not attending meetings, not participating on committees and not adding value.

Board remuneration.

When speaking with founders about board recruitment, the second most frequently asked question relates to how to appropriately remunerate board members.

Venture capital investors rarely seek or accept remuneration for their board roles. As for what to pay other board members, for pre-revenue companies, the answer is largely academic. With limited investment, cash flow has to be the priority. Cash compensation for directors is usually zero. That leaves stock or stock options as the only practical way to recruit, incent and retain experienced directors.

I recommend granting options, at fair market value (as defined by your last equity raise), that vest at the end of each year of service. Options at fair value don’t have tax consequences for directors in Canada or the US. I’d recommend issuing options to each independent director equal to .25-.50% of the company’s overall shares, per year of service. I’d offer a premium to the board chair since he or she typically bears a greater burden of work associated with preparing the board agenda and materials and managing board meetings.

After the coveted Series A round, I’d suggest you add a cash component to the remuneration structure. I recommend an honorarium of $500-$2,000 per in-person meeting, and perhaps half that for teleconference meetings. It’s common to pay directors’ travel and meal expenses, but that can be negotiated. Sometimes a per diem is established to dissuade directors from booking the Four Seasons. Growth-stage and Series B companies and beyond are a different story, and board compensation for those ventures widely varies.

Building an effective, engaged and truly functional board is as important a process as recruiting and incenting a management team, and can be equally impactful on your start-up’s success. This subject matter is covered in much greater depth in one book I’d recommend: Startup Boards: Getting the Most Out of Your Board of Directors (Brad Feld and Mahendra Ramsinghani).

I’m told if I end a post with a call to action and invitation for feedback, my reader and engagement statistics will improve. So, I welcome your feedback and questions. Furthermore, if start-up founders and managers have a topic they’d like me to address in the future, I’d be jazzed to hear from you. My generation used the term “jazzed” to mean enthusiastic about something. According to the Urban Dictionary, it now means “to forcibly evict an unwanted house guest.” I’m inviting everyone to join the conversation – not kicking anyone out.